Portfolio Management Flashcards
What is the portfolio perspective to investing?
The portfolio perspective refers to evaluating individual investments by their contribution to the risk and return of an investor’s portfolio
What are the benefits of diversification?
Diversification allows an investor to reduce portfolio risk without necessarily reducing the portfolio’s expected return.
In what circumstances would diversifying not be beneficial?
If the correlation of all the stocks in the portfolio = +1
What were Markowitz’s conclusions about diversification from his 1950 studies?
Unless the returns of the risky assets are perfectly positively correlated, risk is reduced by diversifying across assets
What is the formula for the diversification ratio?
( Diversification\ ratio = \frac{Standard\ deviation\ of\ equally\ weighted\ portfolio}{Standard\ deviation\ of\ a\ random\ security} )
What is the impact on diversified portfolios during times of financial crisis?
During periods of financial crisis, correlations tend to increase, which reduces the benefits of diversification. Diversification tends to work best when markets are operating normally
What are the three steps in the portfolio management process?
- Planning
- Execution
- Feedback
Which investor has a high risk tolerance, long term investment horizon, low liquidity needs and varying income needs depending on age?
DB pension schemes
Which investor has a low risk tolerance, a short investment horizon and high liquidity needs?
A bank
Which investor has a longer time horizon, DB pension schemes or life insurance companies?
Life insurance companies
A retirement plan in which the firm contributes a sum each period to the employee’s retirement account. Investment decisions and risk sit with the employee, the firm assumes none of the risk. What type of pension scheme is this describing?
A defined contribution pension plan
A firm promises to make periodic payments to employees after retirement. The employer assumes the investment risk. What type of pension scheme is this describing?
A defined benefit pension scheme
Who holds the risk in a defined contribution plan?
The employee holds the risk as the investment risk sits with them
Who holds the risk in a defined benefit plan?
The contributing firm holds the risk as they need to meet a set obligation upon the employees retirement
Who needs to fund the shortfall if investment performance along cannot fund a defined benefit pension?
The employer
Firms that manage investments for clients, are better known as…?
Asset management firms
What is the difference between a full service and a specialist asset manager?
Full-service asset managers are those that offer a variety of investment styles and asset classes
Specialist asset managers may focus on a particular investment style or a particular asset class
A holding company that includes a number of different specialist asset managers, is also known as a…?
Multi-boutique asset management firm
What is the difference between active and passive management?
Active management attempts to outperform a chosen benchmark through manager skill, for example by using fundamental or technical analysis
Passive management attempts to replicate the performance of a chosen benchmark index.
How much of total global AUM is passive?
20% of global AUM
Why has passive management become more popular in recent times?
Passive managers charge investors lower fees, and in part to questions about whether active managers are actually able to add value over time on a risk-adjusted basis
What securities do traditional asset managers invest in?
Equities and fixed-income securities
What securities do alternative asset managers invest in?
Private equity, hedge funds, real estate, or commodities
A portfolio that is owned by a single investor and managed according to that investor’s needs and preferences is called a…?
Separately managed account
What metric do we use to measure the value of the assets in a mutual fund?
NAV
What is an open-end fund?
The management company will sell shared directly to you. They will take your money, add it to the portfolio, and create more new shares
What is a closed-end fund?
When a closed-end fund starts, the company raises a set amount of money and issues a specific number of shares. No new shares are created after that point
What is the formula for the holding period return?
( HPR = \frac{P_1 + D_0 - P_0}{P_0} )
What is the formula for the arithmetic mean return?
( Arithmetic\ mean\ return = \frac{R_1 + R_2 +…+ R_n}{n} )
What is the geometric mean return?
( Geometric\ mean\ return = \sqrt[n]{(1+R_1)(1+R_2)…(1+R_n)}-1 )
What is the difference between gross, net and real return?
Gross return refers to the total return on a security portfolio before deducting fees
Net return refers to the return after these fees have been deducted
Real return is nominal return adjusted for inflation
What is leveraged return?
Leveraged return The gain or loss on the investment as a percentage of an investor’s cash investment.
Which asset class has historically led to the greatest returns and standard deviation
Small cap stocks
Explain the difference between a risk-averse, risk-seeking and a risk-neutral investor?
A risk-averse investor is simply one that dislikes risk
A risk-seeking investor actually prefers more risk to less and, given equal expected returns, will choose the more risky investment
A risk-neutral investor has no preference regarding risk and would be indifferent between two such investments
What graph represents the investor’s preferences in terms of risk and return?
Utility function
How do indifference curves behave for risk averse investors?
Indifference curves slope upward for risk-averse investors because they will only take on more risk (standard deviation of returns) if they are compensated with greater expected returns
What is the capital allocation line?
Possible portfolio risk and return combinations given the risk-free rate and the risk and return of a portfolio of risky assets.
What is fintech?
Fintech: developments in technology that can be applied to the financial services industry
Extremely large data sets that may be analysed computationally to reveal patterns, trends, and associations, especially relating to human behaviour and interactions, are also known as…?
Big data
What are the 4 characteristics of big data?
Volume, variety, velocity, veracity
What is the difference between structured and unstructured data?
Structured data is highly-organized and formatted in a way so it’s easily searchable in relational databases. Unstructured data has no pre-defined format or organization, making it much more difficult to collect, process, and analyze
Programmes to simulate human cognition, are called…?
Artificial Intelligence
What are neural networks?
Neural networks are an example of artificial intelligence in that they are programmed to process information in a way similar to the human brain
Systems that learn and improve from experience without being explicitly programmed are called…?
Machine learning
What is the difference between supervised and unsupervised learning?
supervised learning: the input and output data are labelled, the machine learns to model the outputs from the inputs, and then the machine is given new data on which to use the model
unsupervised learning: the input data are not labelled and the machine learns to describe the structure of the data
A technique that uses layers of neural networks to identify patterns, beginning with simple patterns and advancing to more complex ones, is called?
Deep learning
What is the difference between overfitting and underfitting?
Overfitting occurs when the machine learns the input and output data too exactly, treats noise as true parameters, and identifies spurious patterns and relationships.
Underfitting occurs when the machine fails to identify actual patterns and relationships, treating true parameters as noise.
What is text analytics?
Analyses documents such as PDFs for words and phrases
The use of computers and artificial intelligence to interpret human language, is called?
Natural language processing
What is the difference between algorithmic and high-frequency trading?
Algorithmic trading refers to computerized securities trading based on a predetermined set of rules
high-frequency trading that identifies and takes advantage of intraday securities mispricings.
An electronic medium of exchange enabling transactions without a financial intermediary, is more commonly known as?
Cryptocurrency
Electronic contracts that could be programmed to self-execute based on terms agreed to by the counter-parties is known as?
Smart contracts
What is tokenisation?
Tokenisation refers to electronic proof of ownership of physical assets, which could be maintained on a distributed ledger.
What is the difference between permissionless and permissioned networks?
In permissionless networks, all network participants can view all transactions.
In permissioned networks, users have different levels of access.
What is blockchain?
Blockchain, a digital ledger that records transactions and information in a verifiable and permanent way
What is the difference between fundamental analysis and technical analysis?
Fundamental analysis uses a firms FS whereas technical analysis uses a firms share price and trading volume data
How are stock prices derived?
They are the derived at the point supply = demand. They reflect the behaviour of buyers and sellers
What is the theory behind investor behaviour and trends?
Patterns and trends can be identified and tend to repeat themselves over time, therefore can be used to forecast prices
What is the advantage of using technical analysis over fundamental analysis?
Technical analysis data including price and volume information is observable whereas fundamental data is based on assumptions and restatements
What is the main drawback in technical analysis?
It only identifies changes in trends after the fact
Why is technical analysis useful for analysis of currencies and commodities?
Valuation models cannot be used to determine fundamental intrinsic value for these securities
What information do bar charts show?
High, low, open and close
What differentiates candlestick charts from bar charts?
Candlestick charts have coloured bodies signifying upward and downward movements
What are point and figure charts?
Point and figure charting does not plot price against time as time-based charts do. Instead it plots price against changes in direction by plotting a column of Xs as the price rises and a column of Os as the price falls
Which chart benchmarks an assets closing price to benchmark values such as another stock index of a comparable asset?
A relative strength index
Define an uptrend?
Uptrend: Higher highs and higher lows
Define a downtrend?
Downtrend: Lower highs and lower lows
What are the benefits of including a trendline in a chart?
Drawing a trendline on a chart can help to identify whether a trend is continuing or reversing
What is the difference between a breakout and a breakdown?
Breakout: An upward movement from a downtrend
Breakdown: A downward movement from an uptrend
What is the difference between a resistance and a support level?
Support level: buying is expected to emerge that prevents further price decreases
Resistance level: selling is expected to emerge that prevents further price increases
Breached resistance levels become support levels or the breached support levels become resistance levels is known as…?
Change in polarity
In an inverted head and shoulders pattern, if the neckline is at €100, the shoulders at €90, and the head at €75, the price target is?
Target = Neckline + (Neckline − Head): €100 + (€100 − €75) = €125
How long in years are presidential cycles?
4 years
How long in years are kondraireff wave cycles?
54 years
What is a moving average line?
Moving average lines: Lines used to smooth the fluctuations in a price chart.
What is the rate of change oscillator?
Rate of change oscillator: An ROC or momentum oscillator is calculated as 100 times the difference between the latest closing price and the closing price n periods earlier. Thus, it oscillates around zero.
Outline some of the different types of non-price based indicators of market performance?
- Put/call ratio
- Margin debt indicator
- Volatility index
- Short interest ratio
- New equity issuance
- Mutual fund cash position
How do you calculate the fibonacci numbers sequence?
Fibonacci Numbers: starting with 0 and 1 and adding the previous 2 numbers together to get the next:
0 1 1 2 3 5 8 13 21 34
What number does the Fibonacci ratio tend to over time?
1.6
Who proposed the fibonacci number sequence?
NS Elliot
What is the decennial pattern theory?
The decennial pattern theory states that years ending with a 5 will have the best performance of any of the 10 years in a decade and that those ending with a zero will have the worst.
According to the US presidential cycle theory, the DJIA has the best performance during which year?
The third year following a presidential election
What is the capital market line?
Capital market line: The CML is the optimal CAL and is tangential to the efficient frontier and therefore that point is the market / optimal portfolio
What is the difference between the systematic and unsystematic risk?
Unsystematic Risk: The risk that is eliminated by diversification is called unsystematic risk (also called unique, diversifiable, or firm-specific risk)
Systematic risk: The risk that remains cannot be diversified away and is called the systematic risk (also called nondiversifiable risk or market risk
Which risk do investors expect to be compensated for?
Systematic risk
What 3 factors make up the standard form fama and french model?
- Firm size
- Firm book value to market value ratio
- Return on the market portfolio minus risk free rate
What fourth factor makes up the 4 factor fama french model?
Price momentum
The sensitivity of an asset’s return to the return on the market index, is known as…?
Beta
What is the formula for beta?
( \beta_i = \frac{Cov_{im}}{\sigma_m^2} )
Outline the 7 CAPM assumptions?
Risk aversion Utility maximising investors Frictionless markets One-period horizon Homogeneous expectations Divisible assets Competitive mark
Is the sharpe ratio based on total risk or systematic risk?
Sharpe ratio is based on the total risk of a portfolio not just the systematic risk
what is the formula for the Treynor ratio?
( Treynor\ ratio = \frac{R_p - R_f}{\beta_p} )
What is the M squared formula?
( (R_p - R_f) \frac{\sigma_m}{\sigma_p}-(R_m - R_f) )
Why is an IPS is required?
So the investment manager and the client are aligned.
Whats is an Investment policy statement?
A document that outlines an investor’s goals in terms of risk and return and how the IM will endeavour for this to be achieved.
Is an IPS required by law?
Under certain circumstances yes
What are the components of an IPS?
Description of the clients circumstances, situation and investment objectives Statement of purpose of the IPS Statement of duties and responsibilities of the investment manager Procedures to update the IPS Investment objectives Investment constraints Investment guidelines Evaluation of performance
Discuss the difference between an investors ability to bear risk and their willingness to bear risk?
An investor’s ability to bear risk depends on financial circumstances.
An investor’s willingness to bear risk is based primarily on the investor’s attitudes and beliefs about investments
Describe the 7 investment constraints individual investors face?
Risk Return Tax Time horizon Liquidity Legal Unique circumstances
A manager who varies from strategic asset allocation weights defined in the IPS in order to take advantage of perceived short-term opportunities due to price discrepancies, is known as what sort of asset allocation?
Tactical asset allocation
What is the core-satellite approach to investing?
core-satellite approach invests the majority, or core, portion of the portfolio in passively managed indexes and invests a smaller, or satellite, portion in active strategies
What are the three steps of the risk management process?
identify the risk tolerance of the organization,
identify and measure the risks that the organization faces, and
modify and monitor these risks
Why is it important not to completely avoid risk?
Risk (uncertainty) is not something to be avoided by an organization or in an investment portfolio. Returns above the risk-free rate are earned by taking on risk
Are risk and/or returns under the control of the manager?
While returns for any period are not under the control of managers, the specific risks and overall level of risk the organization takes are under their control
Determining the businesses risk tolerance and implementing policies to monitor and manage the firms risk are features of which types of governance?
Risk governance
What is risk budgeting?
Risk budgeting: Allocating risk to investments) by considering their various risk characteristics and how they combine in the wider portfolio
What is the difference between mortality risk and longevity risk for an individual?
Mortality risk: Risky of dying too soon and not having money in place for family
Longevity risk: Risk of living too long and not having provided for this in your earlier life
How does one manage mortality risk and longevity risk respectively?
Mortality risk is most often addressed with life insurance, and longevity risk can be reduced by purchasing a lifetime annuity
What is duration?
Duration is a measure of the price sensitivity of debt securities to changes in interest rates
The sensitivity of derivative values to the price of the underlying asset is defined as…?
Delta
The sensitivity of the delta to the underlying asset, is defined as…?
Gamma
The sensitivity of the value of the derivative to the volatility of the price of the underlying asset, is defined as…?
Vega
The sensitivity of the value of the derivative to the volatility of the risk free rate, is defined as…?
Rho
The uncertainty about the probability of extreme (negative) outcomes is what type of risk?
Tail risk
What is VaR?
Value at risk (VaR): is the minimum loss over a period that will occur with a specific probability.
What is Conditional VaR?
Conditional VaR (CVaR): is the expected value of a loss, given that the loss exceeds a minimum amount
What is the difference between stress testing and scenario analysis?
Stress testing examines the effects of a change in a key input variable.
Scenario analysis refers to a similar what-if analysis of expected loss but incorporates changes in multiple inputs.
What are the 4 types of risk management?
Risk acceptance, avoidance, mitigation, or transfer.
What is the difference between risk transfer and risk shifting?
Risk shifting: Similar to risk transfer but using derivatives
